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on Central Banking |
| By: | Kohei Hasui (Aichi University); Tomohiro Sugo (Bank of Japan.); Yuki Teranishi (Keio University) |
| Abstract: | This paper shows that the Fed’s exit strategy works as optimal monetary policy in a liquidity trap. We use the conventional new Keynesian model including a recent inflation persistence and confirm several similarities between optimal monetary policy and the Fed’s monetary policy. The zero interest rate policy continues even after inflation rates are sufficiently accelerated over the 2 percent target and hit a peak. Under optimal monetary policy, the zero interest rate policy continues until the second quarter of 2022 and the Fed terminates it one quarter earlier. Eventually, inflation rates exceed the target rate for over three years until the latest quarter. The policy rates continue to overshoot the long-run level to suppress high inflation rates. Furthermore, high inflation rates under optimal monetary policy can explain about 70 percent of the inflation data for 2021 and 2022 years. However, these are still lower than the inflation data. This is because optimal monetary policy raises the policy rates faster than the Fed does. The remaining 30 percent of inflation rates can be constrained by the Fed’s more aggressive monetary policy tightening after the zero interest rate policy. |
| Keywords: | liquidity trap; optimal monetary policy; inflation persistence; forward guidance |
| JEL: | E31 E52 E58 E61 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:upd:utmpwp:051 |
| By: | Kohei Hasui (Aichi University); Yuki Teranishi (Keio University) |
| Abstract: | This paper shows that the Bank of Japan’s monetary policy shares several common points with optimal monetary policy in a liquidity trap to large negative shocks by the recent pandemic. The zero interest rate policy continues even after inflation rates sufficiently exceed the 2 percent and hit the peak. Optimal monetary policy keeps the zero interest rate policy until the second quarter of 2024 and the Bank of Japan continues the zero interest rate at least until the second quarter of 2024. Recent high inflation rates can be explained by a prolonged zero interest rate policy. Average inflation rates from 2021 to 2023 years are 2.2 percent and 2.1 percent in the data and the simulation, respectively. According to scenarios for anchored inflation expectations and long-run natural interest rates, the optimal timing to terminate the zero interest rate policy and a speed of the monetary tightening after the zero interest rate policy change. As anchored inflation expectations and natural interest rates decline, the zero interest rate policy continues longer. |
| Keywords: | liquidity trap; optimal monetary policy; inflation persistence; forward guidance |
| JEL: | E31 E52 E58 E61 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:upd:utmpwp:050 |
| By: | Christoph Boehm; T. Niklas Kroner |
| Abstract: | Existing high-frequency monetary policy shocks explain surprisingly little variation in stock prices and exchange rates around FOMC announcements. Further, both of these asset classes display heightened volatility relative to non-announcement times. We use a heteroskedasticity-based procedure to estimate a “Fed non-yield shock”, which is orthogonal to yield changes and is identified from excess volatility in the S&P 500 and various dollar exchange rates. A positive non-yield shock raises stock prices in the U.S. and around the globe, and depreciates the dollar against all major currencies. The non-yield shock is essentially uncorrelated with previous monetary policy shocks and its effects are large in comparison. Its strong effects on the VIX and other risk-related measures point towards a dominant risk premium channel. We show that the non-yield shock can be related to Fed communications and that its existence has implications for the identification of structural monetary policy shocks. |
| JEL: | E43 E44 E52 E58 F31 G10 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32636 |
| By: | Yannis Dafermos (Department of Economics, SOAS University of London) |
| Abstract: | The European Central Bank (ECB) has recently incorporated climate considerations into its operations. In this paper, I assess whether the ECB’s approach is consistent with the challenges of the climate crisis era. I first identify three transformative implications of the climate crisis for central banking. These are that central banks (i) are becoming less able to control inflation via monetary policy tools, (ii) can no longer ignore their responsibility to support decarbonisation, and (iii) cannot rely on traditional risk exposure approaches to prevent financial instability that stems from physical risks. I then analyse to what extent these implications are reflected in the ECB climate actions and plans, showing that there is a very significant gap between the ECB’s 'tinkering around the edges' approach and the central banking challenges posed by the climate crisis. Using post-Keynesian, critical macro-finance and political economy perspectives, I develop the theoretical underpinnings of a climate-aligned central banking paradigm and analyse the implications of this paradigm for the ECB policy toolbox and mandate. I also identify the ideological and political economy factors that prevent the ECB from undergoing a climate paradigm shift. |
| Keywords: | European Central Bank; monetary policy; financial stability; inflation; climate crisis |
| JEL: | E58 Q54 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:soa:wpaper:264 |
| By: | Luigi Bocola; Alessandro Dovis; Kasper Jørgensen; Rishabh Kirpalani |
| Abstract: | This paper uses high frequency data to detect shifts in financial markets' perception of the Federal Reserve stance on inflation. We construct daily revisions to expectations of future nominal interest rates and inflation that are priced into nominal and inflation-protected bonds, and find that the relation between these two variables-positive and stable for over twenty years-has weakened substantially over the 2020-2022 period. In the context of canonical monetary reaction functions considered in the literature, these results are indicative of a monetary authority that places less weight on inflation stabilization. We augment a standard New Keynesian model with regime shifts in the monetary policy rule, calibrate it to match our findings, and use it as a laboratory to understand the drivers of U.S. inflation post 2020. We find that the shift in the monetary policy stance accounts for half of the observed increase in inflation. |
| JEL: | E58 G13 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32620 |
| By: | Sergio Cesaratto; Eladio Febrero; George Pantelopoulos |
| Abstract: | National Central Banks (NCBs) of the Eurosystem pool profits and losses related to monetary policy operations to form the Eurosystem's so-called 'monetary income'. This is then redistributed - i.e. allocated - among NCBs according to respective capital keys (the participation shares of each NCB to the ECB's capital). Monetary income has relevance for current debates such as that concerning the high fiscal costs of an ample reserve regime as a result of the abundant reserves banks hold in the deposit facility of their respective NCBs. These costs are in fact redistributed through the allocation of monetary income. Nonetheless, exactly how monetary income is pooled and subsequently allocated between Eurosystem NCBs remains rather enigmatic. The aim of this paper is to explore how monetary income is both pooled and allocated. This seems a useful task beyond the aforementioned debate to dissipate other puzzling issues like the costs of TARGET2 imbalances. A more detailed dissemination from the relevant authorities as to the process by which profits/losses are pooled and subsequently allocated is however in our view warranted. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:imk:fmmpap:104-2024 |
| By: | Sangyup Choi (Yonsei University); Kimoon Jeong (University of Virginia); Jiseob Kim (Yonsei University) |
| Abstract: | This paper examines how the call option-like mortgage refinancing structure can generate sign-dependent effects of monetary policy shocks on consumption. Utilizing European data, we confirm that consumption declines more significantly with a higher share of adjustable-rate mortgages (ARMs) in response to contractionary monetary policy shocks. However, we uncover that consumption does not necessarily increase more in response to expansionary shocks in the same countries, resulting in asymmetry. Both household-level microdata and model-based quantitative analysis indicate that refinancing in response to a decline in the interest rate—akin to exercising call options—is the key to rationalizing the asymmetric responses between monetary tightening and easing. Since the incentive to refinance heavily depends on its exercising cost, this mechanism is ineffective in economies where the refinancing cost is high. |
| Keywords: | Adjustable-rate mortgages; Refinancing; Monetary policy; Consumption; Call option. |
| JEL: | E21 E32 E44 E52 G21 G51 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:yon:wpaper:2024rwp-228 |
| By: | Girstmair, Stefan |
| Abstract: | This paper examines determinacy properties in a multi-country open economy framework, focusing on the impacts of dominant currency pricing (DCP), producer currency pricing (PCP), and local currency pricing (LCP) on monetary policy effectiveness. Utilizing a New Keynesian model with three symmetric economies, each guided by Taylor rules, the study extends the framework of Gopinath et al. (2020) to analyze how these pricing paradigms interact with central bank policies to achieve economic stability. The investigation highlights that higher economic openness amplifies interactions among central banks’ policies, complicating the attainment of determinacy. DCP significantly constrains policy parameters ensuring determinacy, particularly in open economies. Conversely, PCP and LCP offer relatively larger determinacy regions, allowing for greater domestic policy control. The findings emphasize the critical role of pricing paradigms and economic openness in formulating effective monetary policies. This study provides essential insights for central banks and policymakers in enhancing global economic stability through tailored policy recommendations based on the chosen pricing paradigm. |
| Keywords: | Determinacy; Taylor rule; Three-country new Keynesian model; Pricing paradigms; Openness |
| JEL: | E31 E52 E58 F33 F4 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:cpm:dynare:082 |
| By: | Peter N. Ireland (Boston College) |
| Abstract: | From the very start of its fifty-year history, the Shadow Open Market Committee advocated for a monetary policy strategy focused on controlling inflation. With time, the rationale for price stability as the principal focus of monetary policy came to be accepted more widely by academic economists and Federal Reserve officials as well. The SOMC also consistently favored an operational approach involving the use of the monetary base as the policy instrument and a broader monetary aggregate as an intermediate target. These features of SOMC strategy, by contrast, have never gained widespread support among academics or at the Fed. This paper outlines the SOMC’s preferred approach, focusing on how the Committee’s money- based strategy and arguments for it evolved over time. It then shows that these arguments still apply with force today. |
| Keywords: | Inflation, Money Growth, Monetary Policy, Monetarism, Shadow Open Market Committee |
| JEL: | B22 B31 E31 E51 E52 E58 |
| Date: | 2024–07–01 |
| URL: | https://d.repec.org/n?u=RePEc:boc:bocoec:1078 |
| By: | Paavola, Aleksi; Voutilainen, Ville |
| Abstract: | We study the effect of collateral eligibility of corporate loans on the pricing of these loans by banks in Finland. Speciftcally, we investigate whether loans that are pledgeable as collateral for central bank borrowing have lower liquidity premia and thus lower interest rates. For identiftcation, we utilize two unanticipated changes in the collateral framework of the Bank of Finland after the COVID-19 pandemic in 2020 and loanlevel corporate credit data from the Finnish implementation of Anacredit. Our main result is that we do not ftnd evidence that collateral pool expansions by the central bank signiftcantly affected interest rates paid by borrowers. The result contrasts with recent ftndings that imply signiftcant effects of similar collateral pool expansions on credit supply. We hypothesize that differences in the institutional setting and economic environment between countries may explain the contradictory results. Our ftndings show that collateral policies may not have similar effects on credit pricing in all circumstances. |
| Keywords: | monetary policy, collateral framework, credit pricing, interest rates, eligibility |
| JEL: | E43 E52 G21 G28 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bofrdp:300517 |
| By: | Christoph Basten (University of Zurich; Swiss Finance Institute; CESifo (Center for Economic Studies and Ifo Institute)); Ragnar Juelsrud (Norges Bank) |
| Abstract: | We show theoretically and empirically how banks' opportunities to crosssell their depositors loans later affect monetary policy transmission. Expected later lending profits motivate banks to set lower deposit spreads to onboard and retain depositors, more the lower policy rates and the greater a bank's cross-selling opportunities. With data on every Norwegian bank household relationship, we exploit that loan cross-sales vary with demographics and so across municipalities. Comparing bank-municipality cells within each bank-year to control for refinancing needs, we find that banks with more cross-selling potential cut deposit spreads more following policy rate cuts and exhibit higher deposit and loan growth. |
| Keywords: | deposit pricing, deposit spread, deposit channel of monetary policy, cross-selling, multi-product banking, multi-period banking, loan spread |
| JEL: | D14 D43 E52 G21 G51 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:chf:rpseri:rp2436 |
| By: | Charles de Beauffort (Economics and Research Department, National Bank of Belgium); Boris Chafwehé (Bank of England); Rigas Oikonomou (UCLouvain and University of Surrey) |
| Abstract: | When taxes do not sufficiently adjust to government debt levels, the Fiscal Theory of the Price Level predicts that other variables, such as inflation and output gap, must adjust to ensure the solvency of public finances. We study the role of optimal debt maturity portfolios in this context, using a New Keynesian model with both demand and supply-side shocks. Our paper offers new analytical insights into the mechanisms through which debt maturity composition affects the trade-off between inflation and output gap: The Persistence, Discounting and Hedging channels. Our findings, based on a rich prior predictive analysis indicate that the key driving force behind optimal portfolio decisions is the Hedging channel. Moreover, the optimal maturity composition of debt is driven primarily by the supply side shocks, rather than by demand shocks. Finally, our results indicate that optimal debt management is a significant margin to complement monetary policy in stabilizing inflation when debt solvency is an important constraint |
| Keywords: | Monetary and fiscal policy, Government debt management, Fiscal theory. |
| JEL: | E31 E52 E58 E62 C11 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbb:reswpp:202407-450 |
| By: | Lara Coulier; Cosimo Pancaro; Alessio Reghezza (-) |
| Abstract: | We match granular supervisory and credit register data to assess the implications of banks’ exposure to interest rate risk on the monetary policy transmission to bank lending supply in the euro area. We exploit the largest and swiftest increase in interest rates since the creation of the euro and find that banks with a higher exposure to interest rate risk, i.e., with a larger duration gap after accounting for hedging, curtailed corporate lending more than their peers. Ceteris paribus, greater interest rate risk entails closer supervisory scrutiny and potential capital surcharges in the short term, and lower expected profitability and capital accumulation in the medium to long term. We then proceed to dissect banks’ credit allocation and find that banks with higher net duration reshuffled their loan portfolio away from long-term loans in an attempt to limit the increase in interest rate risk and targeted their lending contraction to small and micro firms. Firms exposed to banks with a larger exposure to interest rate risk were unable to fully rebalance their borrowing needs with other lenders, thus experiencing a relatively larger decrease in total borrowing during the monetary tightening episode. |
| Keywords: | Interest rate risk, Duration gap, Bank lending channel, Financial Stability |
| JEL: | E51 E52 G21 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:rug:rugwps:24/1091 |
| By: | Iones Kelanemer Holban |
| Abstract: | We investigate the presence of sign and size non-linearities in the impact of the European Central Bank\textquotesingle s Anti-Fragmentation Policy on non-ERM II, EU countries. After identifying three orthogonal monetary policy shock using the method of Fanelli and Marsi [2022], we then select an optimal specification and estimate both linear and non linear impulse response functions using local projections (Dufour and Renault [1998], Goncalves et al. [2021]). The choice of non-linear transformations to separate sign and size effects is based on Caravello and Martinez-Bruera [Working Paper, 2024]. Lastly we compare the linear model to the non-linear ones using a battery of Wald tests and find significant evidence of sign non-linearities in the international spillovers of ECB policy. |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2406.19938 |
| By: | S. Borağan Aruoba; Thomas Drechsel |
| Abstract: | We study how monetary policy affects subcomponents of the Personal Consumption Expenditures Price Index (PCEPI) using local projections. Following a monetary policy contraction, the response of aggregate PCEPI turns significantly negative after over three years. There are stark differences in the timing and magnitude of the responses across price categories, including some prices that show an initially positive response. We discuss theoretical interpretations of our findings and point to useful directions for future theoretical research. We also show how to re-aggregate our cross-sectional estimates and their standard errors, taking into account dependence between different prices using a Seemingly Unrelated Regression approach. Re-aggregation exercises show that changes in expenditure behavior have not accelerated the long-lagged response of inflation to monetary policy. |
| JEL: | C10 E31 E52 E58 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32623 |
| By: | Nobuhiro Abe (Bank of Japan); Naohisa Hirakata (Bank of Japan); Yuto Ishikuro (Bank of Japan); Yosuke Koike (Bank of Japan); Yuki Konaka (Bank of Japan); Yutaro Takano (Bank of Japan) |
| Abstract: | In this paper, we use a counterfactual simulation to analyze the effect on the function of financial intermediation in Japan of the decline in interest rates due to large-scale monetary easing. The results show that the decline in interest rates due to large-scale monetary easing put downward pressure on interest margins on loans and securities investments of banks. However, capital adequacy ratios were not necessarily pushed down significantly, because the decline in interest rates boosted the price of stocks and bonds and reduced credit risk. On the other hand, the improving real economy and lower lending interest rates increased demand from the corporate sector, leading to an increase in loans outstanding. In addition, the improvement in corporate finances due to an improved real economy, lower lending interest rates, and rising land and other asset prices, reduced credit risk in lending and contributed to an increase in loans outstanding. The results of the counterfactual simulation suggest that the decline in interest rates due to large-scale monetary easing contributed to the facilitation of financial intermediation. |
| Keywords: | Unconventional monetary policy; financial system |
| JEL: | E44 E59 G21 G28 |
| Date: | 2024–07–18 |
| URL: | https://d.repec.org/n?u=RePEc:boj:bojwps:wp24e08 |
| By: | Daniyal Khan (Department of Economics, Mushtaq Ahmad Gurmani School of Humanities and Social Sciences, Lahore University of Management Sciences, Pakistan) |
| Abstract: | This paper interprets Pakistan’s monetary system through the lens of a Post Keynesian endogenous money model and argues that the 2022 amendment to the State Bank of Pakistan Act, 1956 has embedded the position of the State Bank of Pakistan (SBP) as an unusually and necessarily accommodationist central bank. On the one hand, this has practical implications. The inability of the Pakistani government to borrow from the SBP has robbed it of a key money creation mechanism and flooded the banking sector with sovereign risk. On the other hand, the replacement of the private sector by the government as the dominant source of credit demand presents an interesting theoretical case in which public credit demand becomes the source of endogenous money creation. |
| Keywords: | Money supply, central banking, financial fragility, State Bank of Pakistan, endogenous money |
| JEL: | E42 E51 E58 B52 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:new:wpaper:2411 |
| By: | Pierre Monnin; Ayanda Sikhosana; Kerschyl Singh |
| Abstract: | By signing the Paris Agreement, South Africa committed to transform its economy to contribute to keeping global temperature rises well below 2C. This transformation will inevitably impact financial institutions and could represent a systemic risk for the financial sector. According to central bank and academic research, an orderly transition should not jeopardise financial stability but understanding transition risks for the banking sector, monitoring them and, when necessary, implementing macroprudential measures is necessary to ensure this stability. This paper is a step towards achieving this outcome. It presents the main transition risks for the South African banking sector, highlighting that the coal value chain is central to these risks. It assesses the banking systems exposure to transition risks in the corporate sector, showing that they are material and widespread. It concludes by suggesting some macroprudential policy options that could address these risks. |
| Date: | 2024–07–22 |
| URL: | https://d.repec.org/n?u=RePEc:rbz:wpaper:11065 |
| By: | Giulia Gotti; Francesco Papadia |
| Abstract: | This paper attempts to fill in the gaps in the European Central Bank's framework review |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:bre:wpaper:node_10172 |
| By: | Domenico Delli Gatti; Tommaso Ferraresi; Filippo Gusella; Lilit Popoyan; Giorgio Ricchiuti; Andrea Roventini |
| Abstract: | We present a multi-country, multi-sector agent-based model that extends Dosi et al. (2019) and incorporates the exchange market and its interaction with the real economy. The exchange rate is influenced not only by trade flows but also by the heterogeneous demand for foreign currencies from financial traders. In this respect, the dual nature of the exchange rate is highlighted, acting both as a transmission channel of endogenous shocks and as a source of shocks. Indeed, differing beliefs bring about real-financial non-linear patterns with feedback mechanisms. Simulations show that the introduction of speculative sentiment behaviour reflects important stylised facts of bilateral exchange rate series. Furthermore, the findings indicate that trend-following behaviour substantially increases financial turbulence and contributes to real economic fluctuations. Finally, we highlight the power and limitations of the central bank as an actor in the exchange rate market, showing that while the central bank's interventions can effectively curb boom-bust cycles, their outcomes differ substantially. |
| Keywords: | agent-based model, exchange rate dynamics, endogenous cycles, heterogeneous traders, central bank interventions. |
| JEL: | E3 F41 O4 O41 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:frz:wpaper:wp2024_10.rdf |
| By: | Jeffrey A. Frankel; Yao Hou; Danxia Xie |
| Abstract: | This paper develops a new econometric framework to estimate and classify exchange rate regimes. They are classified into four distinct categories: fixed exchange rates, BBC (band, basket and crawl), managed floating, and freely floating. The procedure captures the patterns of exchange rate dynamics and the interventions by authorities under each of the regimes. We pay particular attention to the BBC and offer a new approach to parameter estimation by utilizing a three-regime Threshold Auto Regressive (TAR) model to reveal the nonlinear nature of exchange rate dynamics. We further extend our benchmark framework to allow the evolution of exchange rate regimes over time by adopting the minimum description length (MDL) principle, to overcome the challenge of simultaneous two-dimensional inference of nonlinearity in the state dimension and structural breaks in the time dimension. We apply our framework to 26 countries. The results suggest that exchange rate dynamics under different regimes are well captured by our new framework. |
| JEL: | F31 F33 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32644 |